This document summarizes trends in how companies allocate the purchase price ("intangible gap") in business acquisitions among identifiable intangible assets and goodwill. The key points are: 1) Goodwill still represents the largest percentage of the intangible gap at 61%, though this percentage has been declining slowly over the past 5 years. 2) Customer-related intangibles have increased the most significantly over the past 5 years, rising from 5.7% to 12.7% of the intangible gap. 3) Technology-based intangibles represent the second largest portion at 13.5%, particularly driven by increases in allocating to in-process R&D assets.

1. Valuation & Financial Opinions
Trends in the Allocation of Intangible
Assets for Purchase Accounting
By Jason M. Muraco, CFA – jmuraco@srr.com
In the fifth year of our intangible asset allocation study, we noted 2002 to 61.0% in 2006. The downward trend is consistent with our
some interesting trends in the allocation of the “Intangible Gap” expectations given the general “push” for an increase in the allocation
(defined as total assets over the net of the amounts assigned to of purchase price to identifiable intangible assets since the release
tangible assets). Our current look focused on transactions that of SFAS 141, Business Combinations in June 2001.
closed during the calendar year ended December 31, 2006.
Transactions in the Financial Institutional market (i.e., banking, Marketing-Related Intangibles
insurance, etc.) were excluded from our analysis as the economics Relatively unchanged from 2005, marketing-related intangibles
and typical assets within this market are unique (e.g., a large (e.g., trademarks, trade names, etc.) accounted for 6.2% of the
percentage of financial instruments and a low percentage of Intangible Gap in 2006. The most notable change in the capitalization
identifiable intangible assets) and therefore are not necessarily of marketing-related intangibles was in the Computer Software,
comparable to transactions in other industries. Further, the statistics Supplies and Services industry, which accounted for 5.4% of the
discussed in this article are based on an equally-weighted analysis Intangible Gap, more than double 2005 levels. The Communications
as opposed to dollar-weighted results. The equally-weighted results and the Drugs, Medical Supplies and Equipment industries showed
of our 2006 study are summarized in the following chart. downward trends in marketing-related intangibles over the past
three years.
Total (Excluding Financial Institutions) [a]
Technology-Based Intangibles
2006 2005 2004 2003 2002
Number of Transactions 215 557 274 353 398 After goodwill, technology-based intangibles accounted for the
Goodwill largest portion of the Intangible Gap in 2006, representing 13.5%
Percentage of Intangible Gap 61.0% 62.4% 67.3% 61.0% 69.7%
Marketing-Related Intangibles on average. The Drugs, Medical Supplies and Equipment industry
Percentage of Intangible Gap 6.2% 6.3% 5.0% 6.0% 4.4% exhibited the largest increase in the allocation of technology-based
Technology-Based Intangibles
Percentage of Intangible Gap 13.5% 11.3% 11.8% 18.0% 13.8% intangibles over the past three years, with recognition increasing
Customer-Related Intangibles from 23.9% to 53.0% of all transactions. The upward trend in
Percentage of Intangible Gap 12.7% 14.4% 9.9% 8.9% 5.7%
technology-based intangibles within this industry is primarily
Contract-Based Intangibles
Percentage of Intangible Gap 4.6% 4.6% 3.5% 3.7% 5.1% attributable to in-process research and development assets, which
Miscellaneous Intangibles accounted for 60.7% of total technology-based intangibles in
Percentage of Intangible Gap 2.0% 1.0% 2.5% 2.3% 1.4%
2006 (up from 42.9% in 2004). Overall, in-process research and
Source: SEC filings of companies identified in Mergerstat Review . development was the second most common technology-based
All percentage calculations are based on a straight average.
[a] Excludes the following industries: banking and finance; insurance; and brokerage, asset recognized across all industries in 2006, following patented
investment & management consulting. and unpatented technology. Patented and unpatented technology
was recognized in 78 of the 215 transactions analyzed (or 36%).
Goodwill Customer-Related Intangibles
As illustrated in the chart, goodwill still represents the largest The largest year-over-year change in booked intangible assets over
percentage of the Intangible Gap (61.0% in 2006). There is an evident the five-year history of our study was recorded in customer-related
downward trend in this percentage, albeit at a relatively slow pace, intangibles. Customer-related intangible assets include customer
as the amount allocated to goodwill has declined from 69.7% in relationships, customer contracts, customer lists, customer orders,
Patrick A. Brown Gregory A. O’Hara
Director Managing Director
216.373.2993 216.373.2992
pbrown@srr.com gohara@srr.com www.srr.com

2. Valuation & Financial Opinions
and customer backlogs. These intangibles comprised 12.7% of the deferred tax liability is a dollar-for-dollar increase to goodwill. Since
Intangible Gap in 2006, which is materially higher than the 5.7% this adjustment (which has already been accounted for in the
average in our 2002 study. The Manufacturing and the Communi- allocations reviewed in this article) is typically made after valuation
cations industries exhibited the highest increases of the top five firms perform the purchase price allocation work, the initial
industries in customer-related intangibles over the past three years. allocation percentage to goodwill implied by the valuation firm’s
work could be lower than the final allocation percentage after any
Customer relationships were by far the most commonly-recorded
adjustment for deferred tax liabilities (which could be material).
customer-based intangible in the 2006 study, as they were booked
in 130 of the 215 transactions analyzed. The FASB’s dissemination To illustrate this theory, we compared the allocation percentage
of Emerging Issues Task Force (“EITF”) Issue No. 02-17 “Recognition to goodwill both with and without the inclusion of deferred tax
of Customer Relationship Intangible Assets Acquired in a Business liabilities. The following chart summarizes the results of our study
Combination” was referenced in a previous study as a potential for the top five industries (in terms of number of deals in 2006)
reason for the trend towards an increase in the recording of over the past three years.
customer relationships.
EITF Issue No. 02-17 Computer Software, Supplies Drugs, Medical Supplies and
(which was released in Banking and Finance
2006 2005 2004 2006
Manufacturing [b]
2005 2004 2006
and Services
2005 2004 2006
Communications
2005 2004 2006
Equipment
2005 2004
2002) attempted to Number of Transactions 126 105 128 35 77 31 31 142 75 23 31 9 20 32 25
Goodwill
clarify the definition of Percentage of Intangible Gap 85.5% 85.0% 85.6% 60.2% 64.8% 66.3% 67.0% 67.0% 68.2% 70.5% 60.7% 80.2% 37.0% 49.0% 62.6%
Marketing-Related Intangibles
customer relationships Percentage of Intangible Gap 0.2% 0.3% 0.1% 3.0% 5.8% 6.4% 5.4% 1.9% 2.2% 0.5% 3.2% 3.7% 1.9% 3.7% 5.3%
Technology-Based Intangibles
in the context of Percentage of Intangible Gap 0.0% 0.1% 0.0% 15.2% 13.4% 15.1% 12.1% 13.7% 12.2% 2.1% 7.5% 0.0% 53.0% 32.0% 23.9%
recognizing this asset in
Customer-Related Intangibles
Percentage of Intangible Gap 14.3% 14.1% 12.9% 18.9% 13.2% 11.2% 10.2% 13.6% 12.5% 19.2% 17.3% 11.8% 2.3% 10.2% 3.8%
a business combination. Contract-Based Intangibles
Percentage of Intangible Gap 0.1% 0.2% 0.9% 0.7% 1.3% 0.6% 3.1% 3.2% 1.3% 7.6% 11.1% 4.2% 5.7% 5.0% 1.6%
It certainly appears that Miscellaneous Intangibles
Percentage of Intangible Gap 0.1% 0.3% 0.5% 2.1% 1.5% 0.4% 2.2% 0.6% 3.6% 0.1% 0.2% 0.1% 0.1% 0.1% 2.9%
the EITF had an impact Source: SEC filings of companies identified in Mergerstat Review .
on the recognition of All percentage calculations are based on a straight average.
[a] The manufacturing industry includes companies classified in the following industries: automotive products & accessories; autos & trucks; electrical equipment; electronics; fabricated metal
customer relationships,
products; industrial farm equipment & machinery; miscellaneous manufacturing; plastics & rubber; primary metal processing; and valves, pumps, & hydraulics.
as the average
percentage of the total Intangible Gap allocated to customer
The average allocation to goodwill for the Manufacturing industry
relationships increased from 1.6% in 2002 to 11.0% in 2006.
was 60.2% in 2006. Removing the impact of deferred tax liabilities
(for those deals that disclosed such detail) decreases the average
Contract-Based Intangibles
goodwill allocation to 53.9%, nearly a 10% reduction. As such,
The booking of contract-based intangibles was unchanged from deferred tax liabilities appear to have a meaningful impact on the
2005, accounting for 4.6% of the Intangible Gap in 2006. Consistent allocation of the Intangible Gap to goodwill. Further, removing the
with past results, non-competition agreements were the most deferred tax liability offset (i.e., increased goodwill) from the
frequently recorded contract-based intangible in the 2006 study, as Intangible Gap calculation would also have the impact of increasing
they were a recognized intangible asset in 40 of the 215 transactions the relative percentages of recognized intangible assets.
analyzed (or 19%).
Looking Forward
Additional Thoughts
Increases in customer-related intangibles (particularly customer
In general, goodwill (as a percentage of the Intangible Gap) has relationships) have accounted for the largest portion of reallocated
declined over the five-year history of our study. However, the goodwill amounts over the history of our study. We anticipate this
decline is modest and the total allocation percentage to goodwill is trend to continue for those transactions that closed in calendar year
still relatively high. One potential reason for the discrepancy could 2007 given the overall push by accounting firms and regulators
be related to the timing of the work performed by valuation firms. for companies to allocate larger portions of the Intangible Gap
Generally, valuation firms utilize a target company’s preliminary to identifiable intangibles (such as customer relationships). For
opening balance sheet that does not incorporate all post-transaction transactions closing in 2008 and beyond, we look forward to
accounting adjustments (e.g., deferred tax liabilities). Acquisitions analyzing what type of impact more recent regulations (such as the
in the form of stock transactions (which tend to be more prevalent revision of SFAS 141, Business Combinations and the release of
than asset transactions) often book a deferred tax liability since SFAS 157, Fair Value Measurements) may have on the allocation
the acquired assets are usually written-up for book purposes but of the Intangible Gap.
not for tax purposes (i.e., an acquirer does not get the full tax
deductibility benefit of acquired assets in a stock transaction, only
the carry-over benefit). The offsetting adjustment to booking a

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■■■ Purchase price allocations (SFAS 141, IFRS 3, IAS 38)
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■■■ Long-lived asset impairment (SFAS 144, IAS 36)
■■■ Employee stock options and restricted stock (SFAS 123R, IFRS 2)
■■■ Fresh start accounting (SOP 90-7)
■■■ Fair value of financial investments (SFAS 107, IAS 32)
■■■ Fair value measurements (SFAS 157)
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